More awful advice from a former Goldman chairman

By Joseph A. Giannone

NEW YORK (Reuters) - The economy faces a slump deeper than the Great Depression and a growing deficit threatens the credit of the United States itself, former Goldman Sachs chairman John Whitehead, said at the Reuters Global Finance Summit on Wednesday.

This guy was former Chairman of Goldman Sachs, so you can see why Paulson’s thinking is the same as his. This is where Paulson essentially got his “schooling” about the way the world works. (Or at least, the way gov’t finance works.)

Whitehead, 86, said the prospect of worsening consumer credit woes combined with an overtaxed federal government make him fear that the current slump is far from over.

Nothing that massive governments spending cannot cure. But there is no modern day Keynes, unfortunately. We need him more than ever.

"I think it would be worse than the depression," Whitehead said. "We're talking about reducing the credit of the United States of America, which is the backbone of the economic system." Whitehead encountered plenty of crises during his 38 years at the investment banking firm and was a young boy during the 1930s.

Sovereign, currency issuing nations that spend by crediting bank accounts do not need, “credit.” The only potential downside to this spending, if done in sufficient degree and left unchecked, is a decline in the foreign exchange value of the nation’s currency.

Whitehead warned the country's financial strength is at risk due to the sweeping demand for tax relief and a long list of major government spending plans.

The country’s financial strength is at risk precisely because we don’t engage the government to a greater degree (as in, more deficit spending, not less).

"I see nothing but large increases in the deficit, all of which are serving to decrease the credit standing of America," said Whitehead, who served as chairman of the Lower Manhattan Development Corp after the World Trade Center was destroyed during the September 11, 2001 attacks.

The deficit during WWII went to 40% of GDP. With the terrible mess we are facing now in the economy, the deficit is still under 4% of GDP. However, people like Whitehead will cause us to suffer far longer than if we were to address this with aggressive spending.

Whitehead, who helped make Goldman a top-tier Wall Street firm and led its international expansion, left in 1984 to become a deputy secretary of state under Ronald Reagan.

His old boss, Reagan, ran the biggest deficits in post WWII history. That’s why the economy boomed. This guy has selective memory, it appears.

He warned that the country's record deficit is poised to balloon as the public calls on government for more support.

Again, as a percent of GDP smaller than in the 1982-83,1990-91, 2001, recessions.

"Before I go to sleep at night, I wonder if tomorrow is the day Moody's and S&P will announce a downgrade of U.S. government bonds," he said. "Eventually U.S. government bonds would no longer be the triple-A credit that they've always been."

They will. But only because the rating agencies are clueless. They rated toxic subprime debt AAA. They downgraded Japan to the status of Botswana. Nothing to lose sleep over.

There are at least ten "trillion dollar problems," facing the United States, he said, including social security, expanding health insurance, rebuilding infrastructure and increased spending on green energy. At the same time, the public does not want to pay for it.

The public can only “pay for it” with funds provided to it by government spending. That’s the only thing the government accepts for the payment of taxes.

"The public is not prepared to increase taxes. Both parties were for reducing taxes, reducing income to government, and both parties favored a number of new programs -- all very costly and all done by the government," he said.

Government doesn’t need “income.” It spends by crediting bank accounts. The sale of securities and the collection of taxes function merely to maintain a certain level of reserves and that’s tied to the Fed’s targeting of an interest rate. That’s it. End of story.

Large deficits can weaken the country's credit and increase its borrowing costs, which already constitute a significant part of funding to cover expenses. Whitehead said it could take "several years" for the current problems to be resolved.

Japan has a public sector debt twice as large as the U.S. and official interest rates are near zero. No correlation.

Whitehead said he is speaking out on this topic because he is concerned no lawmakers are against these new spending programs and none will stand up and call for higher taxes.

Higher taxes will reduce aggregate demand in the economy even further.

"I just want to get people thinking about this, and to realize this is a road to disaster," said Whitehead. "I've always been a positive person and optimistic, but I don't see a solution here."

It’s a road to disaster if we follow his misguided prescriptions.